Caymans Post

A world within. A state apart.
Thursday, Mar 28, 2024

Why we should all be worried about the crisis at UK pension funds

Why we should all be worried about the crisis at UK pension funds

Volatility has hit the British economy following Prime Minister Liz Truss’ mini-budget announcement.

Britain's mini-financial crisis of recent weeks may look like a problem mainly for U.K. traders and the government of Prime Minister Liz Truss.

But on closer inspection, the situation carries the seeds of a much wider financial reckoning, revealing major vulnerabilities in the so-called shadow banking sector that controls trillions in assets globally.

Comprising non-banks like insurers, investment firms and pension funds, the shadow banking system isn't subject to the same rules as traditional banks, particularly when it comes to requirements to hold cash against market shocks.

Yet those non-banks face growing financial strains amid rocketing inflation, raising the possibility of further bailouts and central bank interventions. To stave off a global crisis, a growing number of officials and economists say regulation is urgently needed.

“If you don't have that view of non-bank finance and the system as a whole, then these things sort of bubble. And they happen very slowly, but when they then go wrong and go the other way, it can happen very fast and that’s what we’ve seen just now," said Iain Clacher, professor of pensions and finance at Leeds University.

Alarm bells are already ringing in the EU and elsewhere as rising rates, soaring inflation and sky-high energy prices stemming from Russia’s war in Ukraine create strains on the financial system. As the world exits a period of record-low interest rates, the U.K. blowup may be a sign of more mini-crises to come.

“It may be more common that we're in this world where central banks are raising rates and also intervening in financial markets to sort of keep them glued together,” said Steven Kelly, senior research associate at Yale University’s program on financial stability.


UK blowup


The crisis that saw the pound drop to record lows against the dollar started when Truss' government unveiled a mini-budget that spooked investors and sparked a major sell-off in the bond market.

U.K. pension funds, which hold around £1 trillion in assets, became stuck in a “doom loop,” where they had to sell more government bonds, known as gilts, to meet cash calls on leveraged bets.

Those sales in turn pushed the price down further.

It was only when the Bank of England stepped by pledging to buy up to £65 billion of gilts until October 14 that the "doom loop" stopped and pension funds gained time to meet cash calls and stop the contagion from spreading.

Having focused too much on the individual health of each pension fund rather than the health of the system as a whole, regulators were blindsided.

"When you take a more discreet view that pensions is regulated here, insurance is regulated here, banking is regulated here, things are missed," added Clacher, a long-term critic of the liability-driven investment strategies that plunged U.K. funds into difficulties.

Plus, he said, low interest rates became a dogma: "It feels to me that there was sort of a belief that interest rates could never really go back up sufficiently or if they did, they wouldn’t go up as quickly as they have. And that lack of challenge to that belief set has got us to where we are."


Global lessons


That's potentially a worldwide problem, particularly as so-called non-banks — including investment funds, pension funds and insurers — have ballooned in size since the financial crisis and in some cases have taken on risks that once sat on bank balance sheets.

The International Monetary Fund said this week that the assets in open-ended investment funds have quadrupled since 2008 and now stand at $41 trillion.

While banks have been forced to build up huge reserves and are now much safer, non-banks don’t have the same ability to swallow losses, particularly in a short-term crunch.

The Financial Stability Board, which is leading global efforts to come up with some kind of regulatory framework, labeled so-called non-banks — including money market funds and open-ended property funds — as villains in the March 2020 “dash for cash” at the start of the pandemic, which also required a massive intervention by the Federal Reserve.

Plus, the FSB’s chair, Dutch central banker Klaas Knot, warned earlier this year of hidden leverage and liquidity mismatches at non-banks — all factors at play in the stress at U.K. pension funds.

Jon Cunliffe, deputy governor of the Bank of England, wrote in a letter to MPs on Thursday that the pension-fund crisis “underlines the necessity” of international regulation of non-banks.

“It is important that we ensure that non-banks, particularly those that use leverage, are resilient to shocks,” he wrote.

“While it might not be reasonable to expect market participants to insure against all extreme market outcomes, it is important that lessons are learned and appropriate levels of resilience ensured,” he added.

A similar issue is at play in the EU debate over the huge cash calls putting pressure on gas and power companies hedging electricity prices in volatile financial markets.


'Safe' assets


Yet perhaps the biggest problem for the financial system was not so much the direct trouble at pension funds but the turbulence caused in government borrowing markets.

It was dysfunction in that market and the potential spillover to the real economy that ultimately prompted the BoE to act to protect the U.K. financial system.

“You could have a pension fund blow up and the financial system keeps working,” said Kelly from Yale University. “It was really about the gilt market.”

Post-crisis regulations have pushed banks, insurers and pension funds to invest more in “safe assets” like government bonds — but those assets aren't immune to a sell-off.

Sharon Bowles, a member of the U.K. House of Lords and a former chair of the European Parliament’s economics committee, criticized “group think” on the safety provided by sovereign bonds and argued pension funds and insurers' investments are not diversified enough. (She also described U.K. pension funds’ use of bonds to collateralize other bond holdings as “unbelievable” and “like a Ponzi scheme.”)

“Things invented to offer safety at an individual level break down when called on in quantity,” Bowles, also a member of the private sector Systemic Risk Council, said in an email. “Thus when there are big events, herd behaviour happens and we get the opposite of the promised stability.”

For Kelly, central banks may well be on the hook for the next blowup — but buying up bonds is easier than recapitalizing banks.

“We've sort of traded in some risk of financial crises for a higher risk of market type instability moments,” he said. “We may not have bank runs, but we have weird blowups of commodity dealers and pension funds.”

Newsletter

Related Articles

Caymans Post
0:00
0:00
Close
Paper straws found to contain long-lasting and potentially toxic chemicals - study
FTX's Bankman-Fried headed for jail after judge revokes bail
Blackrock gets half a trillion dollar deal to rebuild Ukraine
Israel: Unprecedented Civil Disobedience Looms as IDF Reservists Protest Judiciary Reform
America's First New Nuclear Reactor in Nearly Seven Years Begins Operations
Southeast Asia moves closer to economic unity with new regional payments system
Today Hunter Biden’s best friend and business associate, Devon Archer, testified that Joe Biden met in Georgetown with Russian Moscow Mayor's Wife Yelena Baturina who later paid Hunter Biden $3.5 million in so called “consulting fees”
Singapore Carries Out First Execution of a Woman in Two Decades Amid Capital Punishment Debate
Google testing journalism AI. We are doing it already 2 years, and without Google biased propoganda and manipulated censorship
Unlike illegal imigrants coming by boats - US Citizens Will Need Visa To Travel To Europe in 2024
Musk announces Twitter name and logo change to X.com
The politician and the journalist lost control and started fighting on live broadcast.
The future of sports
Unveiling the Black Hole: The Mysterious Fate of EU's Aid to Ukraine
Farewell to a Music Titan: Tony Bennett, Renowned Jazz and Pop Vocalist, Passes Away at 96
Alarming Behavior Among Florida's Sharks Raises Concerns Over Possible Cocaine Exposure
Transgender Exclusion in Miss Italy Stirs Controversy Amidst Changing Global Beauty Pageant Landscape
Joe Biden admitted, in his own words, that he delivered what he promised in exchange for the $10 million bribe he received from the Ukraine Oil Company.
TikTok Takes On Spotify And Apple, Launches Own Music Service
Global Trend: Using Anti-Fake News Laws as Censorship Tools - A Deep Dive into Tunisia's Scenario
Arresting Putin During South African Visit Would Equate to War Declaration, Asserts President Ramaphosa
Hacktivist Collective Anonymous Launches 'Project Disclosure' to Unearth Information on UFOs and ETIs
Typo sends millions of US military emails to Russian ally Mali
Server Arrested For Theft After Refusing To Pay A Table's $100 Restaurant Bill When They Dined & Dashed
The Changing Face of Europe: How Mass Migration is Reshaping the Political Landscape
China Urges EU to Clarify Strategic Partnership Amid Trade Tensions
Europe is boiling: Extreme Weather Conditions Prevail Across the Continent
The Last Pour: Anchor Brewing, America's Pioneer Craft Brewer, Closes After 127 Years
Democracy not: EU's Digital Commissioner Considers Shutting Down Social Media Platforms Amid Social Unrest
Sarah Silverman and Renowned Authors Lodge Copyright Infringement Case Against OpenAI and Meta
Italian Court's Controversial Ruling on Sexual Harassment Ignites Uproar
Why Do Tech Executives Support Kennedy Jr.?
The New York Times Announces Closure of its Sports Section in Favor of The Athletic
BBC Anchor Huw Edwards Hospitalized Amid Child Sex Abuse Allegations, Family Confirms
Florida Attorney General requests Meta CEO's testimony on company's platforms' alleged facilitation of illicit activities
The Distorted Mirror of actual approval ratings: Examining the True Threat to Democracy Beyond the Persona of Putin
40,000 child slaves in Congo are forced to work in cobalt mines so we can drive electric cars.
BBC Personalities Rebuke Accusations Amidst Scandal Involving Teen Exploitation
A Swift Disappointment: Why Is Taylor Swift Bypassing Canada on Her Global Tour?
Historic Moment: Edgars Rinkevics, EU's First Openly Gay Head of State, Takes Office as Latvia's President
Bye bye democracy, human rights, freedom: French Cops Can Now Secretly Activate Phone Cameras, Microphones And GPS To Spy On Citizens
The Poor Man With Money, Mark Zuckerberg, Unveils Twitter Replica with Heavy-Handed Censorship: A New Low in Innovation?
Unilever Plummets in a $2.5 Billion Free Fall, to begin with: A Reckoning for Misuse of Corporate Power Against National Interest
Beyond the Blame Game: The Need for Nuanced Perspectives on America's Complex Reality
Twitter Targets Meta: A Tangle of Trade Secrets and Copycat Culture
The Double-Edged Sword of AI: AI is linked to layoffs in industry that created it
US Sanctions on China's Chip Industry Backfire, Prompting Self-Inflicted Blowback
Meta Copy Twitter with New App, Threads
The New French Revolution
BlackRock Bitcoin ETF Application Refiled, Naming Coinbase as ‘Surveillance-Sharing’ Partner
×